Managing the capital planning cycle: best practice examples of effective capital program management.

• Author: Westerman, Nicole

Just like an operating budget, and in harmony with operating budget development, planning and management of the capital improvement plan should occur in a regular, annual cycle. Because the CIP management cycle comprises so many activities, it is useful to break it down into more manageable parts, each with distinct goals and potentially different "owners." As shown in Exhibit 1, this article looks at the cycle in four phases: financial planning, project identification and prioritization, project management, and monitoring and reporting. Each of these four phases is discussed in some detail and is illustrated by best practice examples from several public agencies.

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FINANCIAL PLANNING

A sustainable capital program is simply not possible without reliable funding sources. For this reason, prudent financial planning is the cornerstone of an effective capital improvement plan. While it is easy for CIP managers to say, "I've identified my projects--now how do I fund them?" most agencies cannot afford to allow the CIP to be based on project needs first and plans for financial stability second. Because resources are always more limited than needs, fiscal discipline should be the ultimate criterion against which all CIP decisions are made. This means:

* beginning with a solid and accepted multi-year financial plan;

* committing to a single-year capital budget and a multi-year CIR preferably with at least a five-year horizon and possibly a 10- or 20-year outlook;

* identifying financial resources and commitments carrying forward from previous CIPs;

* quantifying the debt, if any, to be issued for capital projects over the term of the plan based on debt affordability goals, debt limitations, and debt service projections;

* establishing goals for operating budget ("pay-as-you-go") or reserve funds to be spent on capital projects over the term of the plan;

* identifying other funding sources, including earmarked revenue streams, grants, revolving loans, and development contributions; and

* quantifying the operating costs, savings, and/or revenues that will result from project implementation, and incorporating those results into the financial plan.

Triple-A rated Germantown, Tennessee, is a city of approximately 40,000 people in southwestern Tennessee. (1) The city's financial plan includes a 10-year property tax plan and a five-year operating budget, the first year of which is approved by the Board of Aldermen. These plans, as well as financial policies in general, are developed with the input of the 19-member Financial Advisory Commission that is comprised of residents with financial expertise. The CIP is designed to serve as a planning tool linking long-range plans, the financial plan, and the city's physical development projections.

Germantown's CIP is built partially on a fiscal impact analysis model that projects property development, infrastructure needs, and capital projects in progress over a five-year period. The model analyzes multiple development scenarios based on a range of assumptions. To fund projects, some revenues, such as those from the state-shared Hall Income and Excise Tax, are earmarked for capital projects because they are volatile or their future is uncertain. Fund balance reserves and pay-as-you-go funding are used, when possible, to minimize debt issuance. For example, in fiscal 2004, these two funding sources make up 15 percent and 9 per cent of total CIP funding, respectively. (2) The Office of Research and Budget performs an analysis of the operating budget impacts of each potential project (e.g., the costs of irrigating and mowing the landscaping on new medians) and evaluates those impacts relative to the projected operating budget.

While the binding sources of a water utility are quite different from those of a general-purpose government, financial planning is quite similar. The Contra Costa Water District, which is located near San Francisco and serves about 450,000 customers, develops a 10-year CIP as part of an annual cycle that includes operating and capital budget development and rate setting. Besides a D-year plan for funding capital projects, the CIP estimates operating and maintenance and debt service costs, projects reserve balances, and projects revenue requirements. By projecting rates over a 10-year period, the district is able to absorb one-time revenue shortfalls or unexpected expenditures without being forced to react with fate increases; moreover, by increasing rates in small annual increments--rather than steep, sudden hikes--increases are aligned with the financial plan and have lagged the rate of inflation for the last five years. These increases go virtually unnoticed compared to most tax or rate increases. Area developers even agreed to substantial increases in the district's "facility reserve charges" after participating in a technical advisory committee to review these charges relative to the plant investments required to serve growth. (3)

As a general rule, once an agency has established capital budget limits for the year, projects already in progress or planned in the previous CIP should have first dibs on available funding as long as their validity and funding needs are confirmed. Only then will new projects be considered for any leftover funds, though projects that were not included in previous CIPs might be funded if they meet more stringent...